THE 1990s AND early 2000s witnessed an unprecedented increase in central bank transparency, with New Zealand, Canada, the UK, Sweden, Finland, Israel, Australia, Spain, the European Central Bank, Norway, and several developing countries all adopting an inflation targeting framework for monetary policy, l and many other central banks dramatically increasing the amount of information regularly released to the public. In the U.S., the Federal Reserve began explicitly announcing changes in its federal funds rate target in 1994, began indicating the likely future course of interest rates or "balance of risks" to its economic outlook in 1999, and began releasing individual votes of Committee members in 2002, to name just a few examples (Table 1 provides additional highlights). Yet despite the apparent international consensus that increased central bank transparency conveys economic benefits, there is very little empirical work convincingly demonstrating the existence of any such benefits.

One reason for the shortage of conclusive results may be the ambitiousness of previous empirical studies. Demertzis and Hughes Hallett (2002) look for a relationship between central bank transparency and the level or the variability of inflation and output across countries. But cross-country differences in fiscal policies, institutions, and macroeconomic shocks are often large, and the length of time series since the last central bank regime change in most countries is small, particularly for the many countries that adopted inflation targeting in the 1990s. Thus, Bernanke et al. (1999) note that drawing any conclusions from this type of exercise "is difficult and somewhat speculative" (p. 252); Bernanke et al. nevertheless present evidence that inflation expectations and inflation have come down in inflation targeting countries, and by more than one would have expected ex ante, but in many cases their "control" countries, such as the U.S. and Australia (prior to the adoption of inflation targeting), also had similar experiences. The above authors' evidence is thus suggestive, but is unlikely to convince many of those who may be skeptical. Indeed, Ball and Sheridan (2005) emphasize macroeconomic performance in control countries as well, and come to exactly the opposite conclusion--that once one allows for mean-reversion in inflation and other macroeconomic time series, there is no evidence that adopting inflation targeting has had any benefits, because countries that adopted inflation targeting were exactly those with above-average inflation prior to adoption.

The present paper asks a less ambitious question and, as a result, obtains much sharper results. The primary effect of an increase in central bank transparency--defined in this paper as the amount of information about the goals and conduct of monetary policy regularly released to the public--should be an improvement in financial market and private sector understanding of how the central bank will set policy as a function of the state of the economy. This should lead, ceteris paribus, to an increase in the private sector's ability to forecast the central bank's policy instrument: for example, if the central bank were following a Taylor-type rule, [r.sub.t] = [r.sup.*] + [[pi].sub.t] + [ay.sub.t] + b([[pi].sub.t] - [[pi].sup.*]), then an improvement in the private sector's understanding of what values the central bank uses for r*, a, b, and ~* and exactly how the central bank measures the output gap [y.sub.t] would lead to improved private sector forecasts for [r.sub.t]. (2)

The present paper investigates to what extent we see such an improvement in financial market and private sector forecasts of short-term interest rates in the U.S. over the past 15 years, given the increases in Federal Reserve transparency that took place over that period (Table 1). In particular, we document (1) an improvement in financial markets' ability to forecast the federal funds rate, (2) a reduction in financial market surprises around Federal Open Market Committee (FOMC) announcements, (3) a reduction in financial market ex ante uncertainty about the future course of short-term interest rates, as measured by interest rate options, and (4) a fall in the cross-sectional dispersion of private sector forecasts of short-term interest rates. …

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